A Masterclass In Capital Allocation – Imperial Brands Case Study


Investors in Imperial Brands have done extremely well over the years. If you had purchased 1000 shares in the company at the turn of the century for £3,820, your holdings would be worth £32,000 today – This is without accounting for the £13,330 in dividend you received along the way. This is a compounded annual return of 14.7%. Amazing!




One of the reason the company has done so well is because the underlying economic engine of the business is a great one. I have mentioned many times before that the economics of the tobacco industry are simply wonderful. But apart from Imperial Brands being in a fantastic industry economically, investors in the company have also benefitted by managements great capital allocation decisions over the years. Management have been proven to be adept at timing share buy backs and using debt to fuel growth over the years. And I believe a recent capital allocation move made by the company will prove to be a masterstroke in the years to come.

Two weeks ago Imperial brands announced that it was disposition of a 10% stake in Compañía De Distribución Integral Logista Holdings, S.A.U. (Logista) for £230.8m A chunk of the money raised from the disposal would be used to buy back shares in the company.

Here is why I think the above mentioned capital reallocation is a great one by Imperial. Currently Logista – the company Imperial has sold shares in – is trading at record highs. The company is trading as a P/E ratio of 18. On the other hand, Imperials share price has slumped this year and is trading at very low valuations. The P/E ratio on its shares is close to 11, it has a Free Cash Flow yield of just under 10% and has a well covered dividend yield of close to 5%.

By selling a stake in Logista and buying back shares its own shares, Imperial are essentially selling high and buying low – something all us individuals investor should be proud off. Imperial has so far retired 3,660,000 shares in the company. Existing investors now have a greater ownership stake in the company. Furthermore, existing investors will benefit as the company now pays a lower total dividend. Retiring 3,660,000 shares means the company saves £6,258,600 a year going by the forward dividend of £1.71. The savings the company makes here can be used to pay down debt, re-invest in the business, buy back more shares or pay higher dividends to existing shareholders. As an existing shareholder, what Imperial are doing is terrific. And the company still has approx £40 million of funds left under the buy-back programme. So the longer the price of Imperial shares remain down, the greater the benefit existing shareholders will have as the company can retire a greater amount of shares.





Going forward, I think Imperial will turn out to be one of the better investments amongst the largest UK blue chip companies. This is why I have been buying shares at the current £31 – £33 level. Imperial is now a Top 3 holding in my portfolio. I find shares to be extremely undervalued at these levels and judging by the companies decision to initiate a buy back as opposed to paying down debt or reinvesting in the business, they too find shares to be undervalued.

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